Will the second Greek bailout save the euro?

After 18 months of dithering, bickering and delusion, the leaders the euro zone have finally conceded to the inevitable and cobbled together a second bailout of Greece. The total package agreed to on Thursday – with fresh loans of $157 billion – includes some startling breakthroughs in Europe’s approach to solving the destabilizing euro debt crisis. For the first time, private creditors are expected to pitch in, by absorbing losses estimated at $53 billion. In the process, the euro zone is allowing what is effectively a sovereign default, a drastic step that many of its top officials had been desperate to avoid. And the zone also agreed to expand the activities of the $1 trillion rescue fund formed last year so that it can use its cash more proactively to help other struggling countries — an attempt to squelch the contagion threatening the entire euro experiment.

I have to say that the Thursday agreement is a big step forward for Europe, the most dramatic show of commitment to the euro during the crisis since that bailout fund was first founded more than a year ago. They agreed to take steps that they have long tried to avoid. It’s heartening to see that Europe’s leaders are finally putting their money and their political careers where their lip service has been, and taking real steps towards shoring up their embattled monetary union.

But will it work? Has this second bailout of Greece finally put an end to Europe’s debt crisis? I have my doubts.

First, let’s look at the good news. Greece is not only getting more bailout loans, but also some debt relief. Financial analysts have been insisting for some time that Greece’s debt load – at 160% of GDP – was simply unsustainable. In this package, maturities on a chunk of debt will be pushed off well into the future – up to 30 years – while some will actually be bought back and retired. That will alleviate some pressure on Athens and buy the country more time to implement its reform programs. In theory, Greece could then be better poised to return to growth and better able to pay off its remaining debts.

The euro leaders also expanded the use of their $1 trillion fund, allowing it to buy sovereign bonds on secondary markets to contain borrowing costs and lend money to euro members to recapitalize banks. By permitting money to be used for weak euro members before they actually fall into bailouts, the euro zone took an important step towards preventing future bailouts. On top of all that, Europe’s leaders made a bold commitment to stand behind the zone’s rescued economies indefinitely. The final statement issued at the summit says:

We are determined to continue to provide support to countries under programmes until they have regained market access, provided they successfully implement those programmes.

So far so good. But will all this really work? There are a ton of unresolved issues that, in my opinion, still put the euro at risk.

First, back to Greece. In the final calculation, the real amount of debt relief Greece is getting is rather small – an estimated $37 billion by 2014, according to the FinancialTimes, or a measly 7% of its current pile of debt. How much Greece’s debt is actually reduced will depend to a great degree on how much “voluntary” involvement the euro zone gets from private investors in rolling over, swapping or selling bonds on the terms of the package. So there remains a “kicking the can down the road” element to this second bailout. Therefore, investors may be kept guessing as to whether or not Greece will eventually be able to pay back its debt, and that leaves open the unappetizing prospect that Greece will have to be supported by its neighbors for an unknown period of time.

Secondly, the package for Greece does not directly deal with the debt problems elsewhere in the euro zone. Yes, the new agreement eases the terms of bailout loans to Greece, Ireland and Portugal, and offers other countries (like Spain and Italy) some precautionary financing and assistance. But there is no comprehensive arrangement in place to handle indebted euro members. In fact, Europe’s leaders went out of their way to convince private investors that this package for Greece is NOT a precedent for future bailout arrangements, as the final statement makes obvious:

As far as our general approach to private sector involvement in the euro area is concerned, we would like to make it clear that Greece requires an exceptional and unique solution.

The euro zone made this point in an attempt to stop contagion. The fear all along has been that if private bondholders were expected to take losses, they’d sell off the bonds of other weak euro states, worsening the crisis. So by specifically stating that Greece was a special case, the euro zone was signaling that the losses taken on Greek bonds might not be repeated on future bailouts. The pitch may have worked, at least temporarily. Bonds of Spain strengthened Friday morning.

However, by limiting this agreement to Greece only, the situation in the rest of the zone remains barely changed. The other PIIGS – Ireland, Portugal, Spain and Italy – are still being left to tackle their debt problems and implement reforms on their own, with only marginally more support from the euro zone. That means investors will still be watching and waiting to see if these governments can rein in deficits, control their debt and press on with politically sensitive budget cuts and reforms. In other words, the second bailout of Greece does not mean that there won’t be more destabilizing crises coming down the road.

Lastly, the second bailout of Greece and further changes to the $1 trillion bailout fund adds greatly to the burden of keeping the euro alive. The two Greek bailouts taken together total more than $300 billion – or about 100% of Greece’s GDP. And that’s not including the private sector losses incurred in this second deal. Then add in the two other bailouts, of Ireland and Portugal, of a combined $235 billion, and the price tag for rescuing the monetary union reaches eye-popping proportions. With their open-ended commitment this week, the euro zone’s leaders are pledging to keep the bailout spigot turned on as long to finally squash the debt crisis. They’re hoping it won’t be necessary, thanks to this Greek deal.